By Mr. M.K Agarwal,
CA, Mahesh K Agarwal & Co
You do not have to
pay income tax on earnest money received from a failed deal. But, there are
other income tax implications you should be familiar with, says Mr. MK
Agarwal, CA at Mahesh K Agarwal & Co
When you buy or /
sell a tangible asset, there is usually some earnest money given by the buyer
before he arranges for the full payment. This can range from Rs. 5,000 to Rs.
10,000 for a used car to a couple of lakhs of rupees for a real estate
transaction.
The payment is meant
to seal the deal & the rules of
arrangement are simple. If the buyer backs out, the earnest money given to the
seller is forfeited. If the seller changes his mind, he gives back double the
amount to the buyer. To ensure that both the parties play fair, there is
typically an intermediary who is known to both.
In normal
circumstances, any amount received as advance for the purchase of an asset is a
revenue receipt & is taxed in the year that it is received. What happens if
the money is received from a buyer who fails to keep his commitment & the deal falls through Will the forfeited
amount become the income of the seller and will he have to pay tax on it Under
which income head will the amount have to be declared in the tax return form
As per Section 51 of
the Indian Income Tax Act,1961, if the owner of an asset has received money by
forfeiting any advance money for the asset, this amount will be deducted from
the purchase price of the asset. This is the cost for which the asset was
acquired or / its fair market value (if the property was purchased before 1
April 1981).
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| M.K Agarwal |
Capital Gains Tax..!
Suppose you bought a
property for Rs. 10 lakh nearly 15 years ago, and 2 years ago, you decided to
sell it for Rs. 40 lakh.
The deal was struck
and the buyer gave you earnest money of
Rs. 2 lakh, but later backed out.The
Rs.2 lakh will be treated as capital receipt & you will not be taxed in that year, but the
amount will be deducted from the purchase price of your property when you sell
it in the future.
In this case,the
purchase price will be taken as Rs. 8 lakh ( Rs. 10 lakh Rs. 2 lakh).
In some cases, the
deduction of earnest money from the cost price of the asset pushes up the
capital gains tax of the owner substantially.
In the example (How
much income tax... ), the owner would not have had to pay any tax had he not forfeited
the earnest money. The indexed cost of acquisition without deducting Rs. 50,000
from the cost price would have been Rs. 8.3 lakh. One would be better off
including the earnest money in ones income from other sources & paying tax on it. Is this possible The law is
silent on this because the earnest money is a capital receipt, not income.
Also, the seller must
know that this is a one-way street. If you backed out of the
deal & paid the
buyer Rs. 2 lakh compensation, it would be treated as a capital loss & not
added to the purchase price of the property.You can claim tax benefit on this
only if you were in the business of sale &
purchase of the property.
In such a case, the
loss due to forfeiture would be treated as a revenue loss.
Earnest money is
usually a very small percentage of the total value of the transaction. But,
sometimes it can be higher than the cost price of the asset. Under Section 48
(read with Section 51), if the amount forfeited is greater than or / equal to
the cost of acquisition, the cost of the asset will be taken as nil.
In one such case
involving Mrs. Sunita N Shah (2005) 94 ITD 492 (Mumbai), the forfeited amount
was higher than the cost of acquisition. In such cases, the excess amount is
considered capital receipt and is not chargeable to tax.
The same ruling was
given in the case of Travancore Rubber & Tea Co.Ltd (2000) 243 ITR 158,
wherein the Supreme Court ruled in favour of the assessee.
Tax Impact on Buyer.!
In case the buyer
defaults & the earnest money is
forfeited, he will not be allowed to show it as a capital loss. This was the
verdict in the case of CIT vs Sterling Investment Corporation Ltd (1980) 123
ITR 441. However,if the seller fails to honour the deal & pays the buyer
double the compensation, this will be treated as capital gain because it
amounts to relinquishment of a right by the buyer.In the case of CIT vs Vijay
Flexible Container (1990) 186 ITR 693, it was held that giving up the right to
obtain conveyance of immovable property amounts to transfer of a capital asset.
What happens if the
advance money was for the purchase of a commercial property Can the loss be
treated as business expenditure incurred by the purchaser The amount can not be
claimed as revenue expenditure.
In CIT vs Jaipur
Mineral Develop Syndicate (1995) 216 ITR 469 (Raj), it was held that if the
payment is made for the pupose of acquiring a capital asset, the amount lost
upon forfeiture will not be considered as revenue loss though the amount may
not have the same consequence or / character in the hands of the recipient or
beneficiary.
How Much Income Tax
Does Seller Pay?
Mr. Murugan bought
plot of land in January 1987 for Rs.2 lakh. He agreed to sell it to Mr. Suresh
in January 1998 & received Rs.
50,000 as earnest money. However, Mr. Suresh backed out and his Rs. 50,000 was forfeited. Mr. Murugan sold
the land on 1 January 2009 for Rs. 8 lakh to Mr. Wan. Heres how his gains will
be taxed:
Purchase Price: Rs. 2 lakh
Earnest
Money Received: Rs. 50,000
Deemed
Purchase Price: Rs. 1.50 lakh
Indexed
Cost (in 2008 - 09 ): Rs. 6.23 lakh
Selling
Price: Rs. 8 lakh
Capital
gain: Rs. 1.77 lakh
Tax
payable: Rs. 35,400 ( 20 per cent)
About the author..!
The author MK Agarwal is a CA (chartered accountant) and
Senior Partner at Mahesh K Agarwal & Co and can be reached at
mkcacs@gmail.com
Contact:
Mahesh K Agarwal
& Co..!
Email: mkcacs@gmail.com
MAHESH K.AGARWAL & Co. Chartered Accountants
Mahesh K. Agarwal & Co. was established in the year 1983. It is a leading chartered accountancy company rendering comprehensive professional services which include audit, management consultancy, tax consultancy, accounting services, manpower management, secretarial services etc.
Fellow Member of Institute of Chartered Accountants Of India and Institute of Company Secretaries Of India, Commerce Post Graduate from University Of Rajasthan(Jaipur) and Bachelors of law from Delhi University.
Mr. M.K. Agarwal was enrolled as a member of the ICAI in 1983 and has to his credit an experience of more than 25 years in almost every facet of the accounting profession. He was an elected member of the Northern India Regional Council of the Institute of Chartered Accountants of India for nine years from 1990 to 1999 and has been a member of various standing and non-standing committees of the Regional Council of the Institute.
He has also been the Secretary of the Regional Council of Northern India of the Institute of Chartered Accountants, for the year 1990-1991 & 1991-1992.
Mr. M. K. AGARWAL..!
Mr. M.K. Agarwal is on the board of well reputed Public and Private Limited Companies in a professional capacity and also has been one of the Arbitrators of DSEA (Delhi Stock Exchange Association Ltd) in 1990
Mr. M. K. Agarwal is the founder Treasurer of Shri Agresen International Hospital, Pitampura & the Vice President of Bharat Vikas Parishad (North Delhi). Mr. M. K. Agarwal is the Senior Partner of the company and in that capacity looks after the entire range of practice relating to Audit, Direct Taxes including planning for corporate & non-resident Indians and rendering of Consultancy on Accounting, Company Law, Taxation, Capital market & FEMA matters.
Mahesh K. Agarwal & Co. is a professionally managed firm.
The team consists of distinguished chartered accountants, corporate financial advisors and tax consultants. The firm represents a combination of specialized skills, which are geared to offer sound financial advice and personalized proactive services. Those associated with the firm have regular interaction with industry and other professionals which enables the firm to keep pace with contemporary developments and to meet the needs of its clients.
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